Memo 1: January inflation trends in the right direction… but will it be enough?
Canada’s Consumer Price Index rose 5.9% in January, a welcome slowdown from December’s 6.3% reading, and indicating the Bank of Canada’s tough love approach to rates is finally taking hold. Analysts and borrowers alike anticipated this month’s report with bated breath as it’s a key reassurance the central bank will stick to its promised rate hold stance, rather than bend to the will of an overheated economy.
The BoC has been grappling with runaway inflation over the past year, implementing a series of rate hikes since last March, bringing the benchmark cost of borrowing from a pandemic-era low of 0.25% to 4.5% today. However, inflation has proven sticky, remaining well above the central bank’s mandated 2 - 3% target range.
Other sets of stronger-than-expected economic data – such as this month’s smashing jobs numbers, and a hotter-than-hoped for US CPI report – have raised doubts the BoC can truly commit to a rate hold in the coming months, as it stated in its January 25th announcement.
The January print, thankfully, is just what the central bankers want to see – and it has granted policymakers the much-needed breathing room to keep the overnight lending rate at status quo, with no change widely expected in the bank’s next announcement, on March 8.
“Quite frankly there are no BoC implications stemming from this report in my view,” writes Derek Holt, Vice President and Head of Capital Markets Economics at Scotiabank. “The BoC has made it clear they are on a conditional pause and that evaluating the condition will take more than a lousy 3–4 weeks and one or two inflation reports since they embraced it on January 25th. The March 8th statement should be short and sweet with no policy changes.”
However, when we take a closer look at the January basket of goods, it’s clear persistently high food, gas and shelter prices continue to hit consumers. While core inflation – which strips out food and energy prices – came in at 4.9%, gas prices rose the most month-over-month of all CPI items, up 4.7% from December and 2.9% year-over-year. According to Stat Can, the increase can be attributed to refinery closures in the southwestern US, following winter storm Elliot. Food prices also accelerated, up a whopping 10.4% from the same time last year, mostly due to rising meat costs.
In what’s a bit of a self-fulfilling prophecy, mortgage interest costs – which make up a chunk of StatCan’s shelter prices measure – rose a sizzling 21.1% in January. That’s the largest increase since September 1982 and outpaces the 18% increase recorded in December. This is largely thanks to the steep variable mortgage rate hikes the economy has absorbed over last year, while fixed mortgage rates have soared in tandem with the bond market.
A lofty mortgage interest index highlights the high debt loads carried by Canadians – and a major headwind risk should the economy indeed be beset by recession in the coming months. BoC Governor Tiff Macklem has warned the full effects of his rate hiking cycle will take several months before it is fully felt by overly-leveraged Canadians.
However, the cooler housing market is starting to make itself known in the rate of inflation, with shelter prices slowing to 6.6% growth (down from 7% in December).
Memo 2: Soaring bond yields erase early fixed-rate discounts
In somewhat of a contradictory turn, bond markets – which are highly inflation-reactive – didn’t seem to welcome the lower CPI print, with the five-year government bond rising 13 basis points on the 21st (the day CPI was released) to 3.58%.
But it may just be that markets aren’t buying into the optimism posed by softer CPI – yet. Canadian investors and indexes are influenced by rising yields in other major global economies, and the US five-year treasury yield has been on a tear lately, up 51.3 basis points in the span of a month. Markets will likely need to see evidence of both softer US inflation and labour numbers on both sides of the border before the bond market begins to really, effectively, chill.
Indeed, Canada’s recent five-year yield gains have proven sticky, remaining in the 3.5% range thus far this week. That’s set the stage for lenders to increase their fixed-rate mortgage products, and a number have done so over the course of this past week, with today’s lowest five-year (high-ratio) fixed now at 4.59%, and the best big bank rate at 5.04%. Should yields continue to put upward pressure on fixed rates, borrowers can expect more increases in the days to come.
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Memo 3: US Fed minutes hint at more – but smaller – hikes to come
The US Federal Reserve – the Bank of Canada’s American counterpart – released the minutes from their January 31st - February 1st meeting this week. These typically offer new morsels of insight behind policymaker deliberations, with this most recent crop explaining the reasoning behind their 0.25% hike, which brought the federal funds rate to a range of 4.5% - 4.75%.
Perhaps the biggest takeaway is the Fed will indeed stick to its hiking cycle in the months to come, until it sees some real headway on inflation. American CPI rose 6.4% in January – higher than the forecasted 6.2% analysts had hoped for. However, policymakers are looking to slow the pace of hikes considerably, ideally waving adieu to the “jumbo” 50 - 75-bps bumps of months past.
“Market participants interpreted incoming data as pointing to moderating inflation risks,” reads the minutes document. “Against this backdrop, market participants judged that the FOMC would likely slow the pace of rate increases further at the current meeting, and respondents to the Desk’s Survey of Primary Dealers and Survey of Market Participants widely expected the Committee to implement a ¼ percentage point increase in the target range for the federal funds rate.”
An analysis written by BMO Senior Economist and Director of Economics Sal Guatieri further breaks it down:
“The minutes of the last policy meeting suggest the FOMC is strongly committed to extending rate increases (yes plural) until it sees sustained progress on inflation,” he writes. “This progress needs to cut ‘across a broader range of prices.’ Falling goods prices and easing rents alone won't cut it; softer services inflation is now the focus of attention, along with a desire for looser labour markets and slower wage gains. Members remain "highly attentive to inflation risks".
The US Federal Reserve’s next rate meeting is scheduled for March 21 -22.
The bottom line
Borrowers – those north of the border, at least – can be reassured that variable rates should remain stable in the months to come, as the latest inflation numbers back the Bank of Canada’s promise to hold on rates. However, there remains considerable volatility in the market, as the US is seeing slower progress in its own inflation battle, and other data prove economies continue to run hot. If you’re currently in the market for a new mortgage, keep in mind that rates remain highly sensitive to current economic conditions, and things may shift quickly in the short term.